Category: Forex Trading Strategies

Dr Elder’s approach to trading

Dr Alexander Elder is one of the well known personalities in the retail trading circle. He has written extensively on retail trading and some of his approach and ideas are popularly used by many traders.

Some of his views and methodology are visited below.

How much to risk per trade?

Risk control is single handedly the most important portion of a successful trading venture. The 2% rule states that you should never risk more than 2% of your account equity on any single trade. If you have a $100,000 account, you should only be allowed to risk $2,000 on any single trade. If you had planned your entry, exit and permitted risk level, it will be easy to calculate how large your position should be. You just need to make sure that, when your stop loss order is hit in an event of adverse price movement, the amount of losses sustained should never be more than 2% of your account capital.

How much to risk your account or portfolio at any point in time?

Elder suggest that you should limit your risk to 6% of your account as a whole at any point in time. For example, you have a $100,000 account and risk $1,000 on every trade, you should not have more than 6 open positions at the same time. It will also be prudent to limit your maximum monthly loss to 6% as well. That means, if you have already had 3 losses which amounts to 3% of equity, you will only be allowed to open 3 more positions, risking another 3% of your account only.

Triple screen analysis

Dr Elder proposed analyzing the markets based on his triple screen trading system. Basically, you will analyze the markets over 3 different time frames. First, determine the timeframe that you are going to trade in and include another timeframe of a higher magnitude and another timeframe of a lower magnitude. For example, if you are looking to trade the daily timeframe, you will also look at the weekly timeframe which is of a magnitude higher and also the 4 hourly timeframe which is a magnitude lower. Now, if the weekly timeframe signals a macro up trend, you will look for long entries or buy setups in the daily timeframe while refining the exact entry point utilising the 4 hourly timeframe or any other timeframes of a lower magnitude than the dailies. These can be 1 hour, 15 mins or 5 mins charts.

Using technical tools

In choosing technical tools, it would be safe to limit yourself to a maximum of 5 different technical tools or indicators to prevent your chart from getting too cluttered and impair your judgment instead. Some suggestions are moving averages, moving average envelopes and MACD lines and histogram.

Moving averages are among the simplest to understand yet immensely useful indicators out there and which are mentioned many times in this blog as well. They are also incredibly versatile and can be used in many ways. First, its slope identifies the direction of change in the public’s mood. A rising moving average reflects bullish sentiments while a falling one reflects bearish sentiments.

Exponential moving averages are preferred over simple moving averages as they are more sensitive to price changes and momentum.

Moving average envelops or channels are simply 2 additional lines calculated by adding and subtracting a volatility number to a moving average to form a line above and a line below it which should contain most price movements. These can be simple adding and subtracting a simple percentage number to it or it can be a standard deviation of past price movements. This is the basis of the Bollinger Bands which commonly adds a +/- 2 standard deviation of price onto a 20 period EMA.

The MACD is a trend following momentum indicator that is comprised of 2 lines. The MACD is calculated by subtracting the 26 period EMA from the 12 period EMA. The second line is a 9 period EMA of the MACD, and is commonly called the ‘signal line’ and it acts as a entry trigger for buys and sells when it crosses above and below the MACD line respectively.

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Can you corner the Bitcoin market?

What is cornering?

First thing first, cornering a market is in short trying to game the system and push up the price of an asset so as to profit from the price distortion. This is done by having monopolistic power in the market place, whether or not you are a monopoly. The important thing is to be the biggest player on the field.

Wikipedia defines it as “getting sufficient control of an asset to allow the price to be manipulated, or, to have the greatest market share in a particular industry without having a monopoly.”

What is Bitcoin?

Bitcoin is a virtual currency, digital currency and/or crypto-currency that was created by a mystery guy as a means of payment or possible store of value that is free from control of governments and therefore avoid the perceived flaws of the current financial system and use of fiat currencies. This may or may not be the case, and unless we can speak to the original creator, the real purpose that this technology is supposed to serve is open to interpretations.

New bitcoins are created or mined using specialized software and hardware built for this sole purpose. The difficulty and therefore the duration of mining the next coin increases exponentially with the total amount capped at 21 million. There are many other virtual currencies popping up but bitcoin still dominates in terms of acceptability and usage.

Whether bitcoin is considered an asset or a currency is open for debate and we are not doing it here. Points to note are that the price of it in USD or any countries currency varies wildly and there is a fixed amount of it, at least for now. Currently, about 12 to 13 million had being mined out of a possible 21 million. The value of a bitcoin is still defined by fiat currencies.

At the time of writing, the price of bitcoin has been hit hard by the collapse of Mt. Gox and the recent announcement from IRAS that defines bitcoin as an asset and subjected to tax. The 30 day price range is USD 436 to USD 710 and about 12.6 million coins were mined so far as informed by the bitcoincharts website.

Can it be cornered?

I will start by estimating the amount of financial resources needed to pull this off.

Assuming the price is fixed at USD 500, the total value of the coins in circulation will be about USD 6 Billion. So Bill Gates can spare less than 5% of his net worth and owns half of all the bitcoins out there.

However, in the course of buying up the Bitcoin, he will need to pay a higher and higher price as the supply on the market dwindles. Let’s assume a price sensitivity of 20% per million Bitcoin supply reduction.

By the time he intends to buy the 6th million of Bitcoins, price would have probably hit USD 1,245, and that was assuming a linear increment in prices. An exponential increase would be more likely.

His attempt to get 6 million bitcoins or half of all bitcoins in circulation now will most likely cost about 4.9 to 6.5 billion USD.

bitcoin corner cost

On the other hand, if the prices are so sensitive to buying pressure, then it might make sense to cash out earlier. A peculiar difference from other valuable commodities like gold or diamond is that, while they are scare, there isn’t a hard figure to the total amount present. Bitcoin on the other hand has a fixed amount at 21 million. Would price be compelled to move at the same velocity both up and down?

Problems with executing an effective corner of bitcoin

Another factor that might affect the success of such a scheme is the impact of such an event on the confidence of the new currency itself. The extreme price gyrations might force weak hands to exit the market altogether. There will also be very few means of controlling or negating such an event as compared to other market cornering episodes in history.

Past cornering attempts often involved lots of leverage which will force the perpetrator to liquidate due to cash flow or liquidity problems, like what happened to the Hunt brothers and their silver corner. Bitcoin’s decentralized nature also meant that there is little the state can do to counter the effects. For example, by announcing a market freeze, forced liquidation of positions or other regulatory tools available to the state in other financial or asset markets.

This in fact can also act as an argument as to why the bitcoin market cannot be cornered. Up until now, putting illegal trades aside, most business owners who accept bitcoins as payment have the freedom to accept any other fiat currencies in circulation as payment. It would be unlikely for customers to pay for a cup of coffee in bitcoin if they can buy it at USD 5 instead of using bitcoins worth USD 7 for example. In short, people can simply not buy more bitcoins to use as a payment tool until the price has fallen to an acceptable level.

So can it be cornered or what?

It can of course be done by anyone or any parties who are willing to commit vast amounts of capital but the probability of success is actually lower and profit potential subdued simply because as a payment tool, there are plenty of substitutes out there (fiat currencies) or as a store of value (gold, diamonds, and other rare goods). Bitcoin is basically a commodity that has no ‘natural users’ or consumers of it to make it a must have item in contrast to copper for example, which has a real world usage of it.

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How to plan to be profitable

In order to be profitable trading the market, you have to look at your trading performance or the feasibility of your trading strategy taking into consideration various factors. These includes, hit rate, risk to reward ratio, leverage and risk management.

The art of not predicting the market

Yes, you heard me right. It is not possible to predict or forecast exactly where the market is going. Is it going to trend up or down or range till eternity? It does not matter. The keyword here is ‘exactly’. You do not have to know precisely where the market is going to profit from it. You just need to be consistent. Heck, you do not even have to be right most of the time in order to come out ahead.

What you can do is trade in the direction of the prevailing trend. There are many ways to do it. You can simply do a visual scan and if price is moving upwards it’s a uptrend, downwards and it’s a downtrend or choppy and its ranging! You can also place a moving average on the chart and if price is trading above, it is a uptrend, trading below and it is a downtrend. Likewise, if it is trading near the moving average and not going far with the moving average line appearing to be horizontal, it is a ranging.

You definitely will not be right every time in gauging the trend or it can switch trend directions almost immediately but unless you can forecast the future, this is to be expected. However, by trading in the direction of the current trend, you can at least increase the probability that you are trading with the trend. You can control the process, but you cannot control the results. Just make sure you are doing the right thing and stop worrying about stuff you cannot change.

High hit rate does not equates to profit

Hit rate is simply the percentage of times you close a winner out of all your trades. For example, out of 10 trades, Trader A bagged a winner 7 times. That would translate to a hit rate of 70%. However, that does not mean Trader A had made a profit overall. He could be trading with a 20 pip take profit level and a 50 pip stop loss. That would mean he made 140 pips on the 7 winners but made a loss of 150 pips on the 3 winners. He will be down by -10 pips.

Or, take Trader B who made 9 losers of 10 pips each but a single winner worth 100 pips. He would still have gotten a net +10 pips profit. His hit rate would be just 10%.

Risk to reward ratio

Risk to reward ratio or RR ratio, is simply how much you risked to try and book a winner. Trader A will be trading a 5:2 ratio and Trader B a 1:10 ratio. Again, on its own, it does not say anything about you profitability. On a statistical level, it is easy to deduce that a higher ratio will naturally reduce your hit rate. It is definitely easier to hit more winners when you take profit at 20 pips and have 50 pips of negative room to move. To be profitable, you will need to obtain a hit rate of at least 72%.

This is how to come up with your break even requirement.

Assuming P as your probability of winning, and therefore, (1-P) as your probability of losing, W as amount of winning pips and L as amount of losing pips. The hit rate you will need to at least break even is calculated as follows.

P = L / (W + L)

The formula is derived as follows:

W(P) – L(1-P) = 0

WP – L + LP = 0

WP + LP = L

P = L / (W + L)

So in the case of Trader A will be 50 / 70 or 0.714, which translates to a minimum 72% hit rate.

Leverage used should be determined by risk management rules

Leverage can give more bang for the buck and amplify your profits. Likewise, it can also help to burn your account into the ground faster with reckless risk taking. The level of leverage to use should be determined by risk management rules and the volatility of the returns your trading strategy or trading plan generates.

As a general thumb of rule, the losses from any one single trade should not exceed more than 5% of your account size. Preferably, it should account for a maximum of 2% only. For example, if you have a $10,000 trading account, it will not be prudent to risk 10% or $1,000 per trade. It will only take 5 losers to reduce your account size to half. Remember to ensure you can survive to trade another day. It would be tragic to be wiped out and have no more capital left for you to take part in profitable trades later. By risking only 2% per trade, it would take 50 losers to run it down to half.

For example, you spotted 2 trading opportunities which would hopefully net you 120 pips by risking 40 pips, and another which could give a possible 30 pips by risking 20 pips respectively. Assuming an account size of $10,000, you should only be risking $200 per trade. This would mean your trading sizes are 50,000 units and 100,000 units for the 2 trades respectively.

Trade 1, if you lost 40 pips at 50,000 units. (0.0040 x 50000 = $200)

Trade 2, if you lost 20 pips at 100,000 units. ( 0.0020 x 100,000 = $200)

This is how you size your trades and normalized the risk across all trading opportunities.

Finally

Trading the forex market or any other financial and asset market might not be as simple as simply opening your trading platform and just fire off trades from your hip. But these are just a few simple steps and planning you can do that can greatly increase the odds of winning in your favor.

 

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RSI Trend following strategy

This strategy will use RSI to enter trades with the prevailing trend instead of looking for trades that bets on mean reversion.
In essence, we will be buying when its Overbought and sell when its Oversold.

Rules:
Set RSI (9) on with 40-60 overbought oversold lines.
For longs:
When a bar closes with RSI above 60, we will go long at the open of the subsequent bar.
We will have our stop loss at the low of the past 10 days and trail as such.
We will also exit when a bar closes with RSI below 40. In which, we will have stopped and reversed our position to go short.
For shorts:
We will do the opposite and go short when RSI goes below 40 and place our stops at the 10 day high.

RSI and 10 day exit strategy

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Two Moving Average Price Crossover

Place 20 EMA and 30 EMA on USDJPY 1H chart.

Rules for entry:
For Longs/Buys, wait for price to CLOSE above both EMAs and place a Buy order above the high of the bar. Stop loss will be placed at the low of the bar.
For shorts, do the reverse.
Exit current position and reverse when the opposite trade signal appears.

As with all trend following systems, this works best in a trending market and is not good for ranging or whipsaw periods.
You can add ADX as an additional filter. Enter trades only when ADX is above 25, for both Buys and Sells.

Note that this strategy is only concerned with whether price has closed above or below the 2 EMAs. It does not matter if the faster EMA is above or below the slower one.

This differs from the other two MA crossover strategy.

2 ema price cross

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Two Moving Average Crossover

This trading strategy is both simple and effective. You can trade a few currency pairs or even other markets together to get some diversification. This will increase your chance of catching a trend and reduce the effects of whipsaws and trading ranges.

Rules:
Place 12 EMA and 30 EMA on USDJPY chart. Timeframe will be 4H.

For longs:
Long entry signal appears when the faster EMA, which is the 12 period one in this case, cross above the slower 30 period EMA at the close.
Create Buy order 2 pips above the high and stop loss will be 2 pips below the low of the same bar.
For shorts:
When at close, 12 EMA has crossed and gone below 30 EMA.
Create sell order 2 pips below the bar with stop loss 2 pips above the high.

This is an ‘always-in’ trading strategy. If you are long, you will exit and go short when a sell signal appears.

This strategy works well on longer time frames, 1H, 4H and Daily charts.
If you trade on daily time frames, you can check all the charts once a day nad setup orders if you find signals. A less stressful yet profitable scenario!

2 ema cross

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Simple Moving Average Cross

It may come as a surprise to some but the moving average indicator can be a complete trading system on its own with clear objective entries and exits.

FX pair: Any
Timeframe: 1H or Daily chart
Indicators: 50 EMA

Rules:

Open EUR/USD chart and choose the 1 Hr time frame.
Place the 50 EMA indicator and wait for the candle to CLOSE on the other side of the EMA line.

Long/Buy when price bar cuts EMA from below and CLOSE above it.
Short/Sell when price bar cuts EMA from above and CLOSE below it.

This MA price cross strategy is an always-in trading strategy where you are always in the market and an exit would mean opening a new position in the opposite direction. For example, if you were originally short 1 lot, you will enter a 2 lot buy when a new BUY signal occurs. One lot will be used to close your short position and another lot to open a new long position.

Examples:

The first trade in this example is a SELL at 1.2589, which is closed out shortly at 1.2632, incurring a 43 pip loss.

The second trade is a BUY at 1.2632 which is profitable and is exited at 1.3078, netting a hefty 446 pips profit. This trade on the EUR/USD, 1H timeframe, happens to be held for almost 8 days, which would make it into a medium to long term position. If it makes money, who cares anyway.

eu-1h-1ma-1 eu-1h-1ma-2

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Simple Opening Range Breakout

The London market is the most active FX market of the 3 major financial centers and where most trades take place. Therefore, it is logical to deduce that most position traders will place their bets and enter their positions when there is maximum liquidity.
We are trying to make use of the trend that can develop out of this kind of activities. The opening range trend can be observed on most market opening times. These include the Asian and US market opens as well. However, we will stick with the London market hours as there is a greater chance of it happening.

This strategy is most effective on Europe currency pairs.
GBP/USD, EUR/USD, GBP/JPY and EUR/JPY.

This is an intraday trading strategy. The chart timeframe will be 1H.
The important hour we are looking at is from 6 GMT to 7 GMT.

Rules:
At the close of the 6 GMT bar, place a Long/Buy order 2 pips above the high of the bar and a Short/Sell order 2 pips below the low of the bar.

Initial stop loss is the other side of the opening bar. When the trade goes into positive territory, trail your stop using the Parabolic Stop and Reverse indicator (or SAR). When using SAR to set stop loss point, always use the value of the previous bar that has closed, so it would not keep changing.
I would take only a maximum of 2 trades per day, if the first trade is a loser. Because, it price chops around, then there are not enough buying/selling strength around and it does not make sense to stay around!
Other ways to trail includes using a 20 EMA, a time stop (exit position at end of day). A very aggressive way to trade is to not set only initial stop loss and never trail it. Instead, I will only get out of my trade when a opposite trade signal appears. Meaning I can keep getting long and pyramiding for 5 days straight and getting out and turning short on the 6th day when a short signal appears. You can see some spectacular profits trading this way but it does not happen very often. Also, it greatly lowers your win rate. So there is a tradeoff here as always, between risk and return!
eurusd-LD BO

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Inside Bar Breakout Trade

This is a simple strategy that does not make use of any indicators, just price bars.
This strategy can be traded on any time frames and any currency pairs or even non currencies. I have success trading the Nikkei225 and other related stock index futures as well.

There are many definitions of what qualifies as a valid inside bar. To me, the entire inside bar, with its high and low should be inside the high and low of the previous bar. It does not matter what the open and close combinations are.
Once an inside bar is observed, set a limit order to long on a breakout 2 pips above the high of the inside bar or set a limit order to short on a breakout 2 pips below the low of the inside bar.
I would also use a EMA as a filter. For example, if an inside bar appeared on while price is trading below the EMA, I will only take shorts. Vice versa, if the inside bar appeared above the EMA, I will only take long breakouts.

Steps:
Currency pairs I trade this on includes EUR/USD, GBP/USD and GBP/JPY. GBP pairs are especially suited for breakout strategies as they are sufficiently volatile.
Open GBP/USD chart and go to 1H timeframe.
Add 20 EMA.
Start to look out for inside bars on close. Alternatively, you can use the following indicators to help spot inside bars.
[add indicators!!!]
Initial stop loss will be on the other side of the inside bar. If the trade goes our way, a trailing stop is placed at the EMA.

For Shorts
If we are short, we will exit the trade when price closes ABOVE the EMA.
Alternatively, you can trail more aggressively by placing a stop above the highs of the previous 2 bars.

For Longs,
If we are long, we will exit the trade when price closes BELOW the EMA.
Or, you can trail aggressively by placing the stop loss below the lows of the previous 2 bars.

Our initial stops will often times be really small, sometimes even less than 10 pips on 1H timeframe. However, winning trades often generates profits of more than 2 times risk.
Example below shows GBP at 1H timeframe, and 3 trades would have been taken. The first inside bar has a high of 1.5389 and a low of 1.5371. Therefore, we will place a limit order to short at 2 pips below the low, which will be 1.5369. Likewise, the stop loss level will be at 2 pips above the high, at 1.5291.
The trade gained +99 pips on a stop loss of 22 pips, yielding a 4 times risk reward ratio. However, there were 2 losers during the same period that cost us -21 pips and -13 pips respectively.
gbp-1h-inside bar BO trade1 gbp-1h-inside bar BO trade2

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20 SMA Envelope and ATR

Suggested currency pair: GBP/USD
Timeframe: Daily, 1H
Indicators: 20 period SMA with 0.5% envelope applied, 14 period ATR

Rules:
Long at open of next bar when price close above the upper bound of the envelope. Initial stop loss is ATR of the signal bar.
Short at open of next bar when price close below the lower bound of the envelope. Initial stop loss is ATR of signal bar.
If trade is stopped out, we will wait until a new trading signal appears.
If the trade is going for us, we will keep our trade open until the opposite trade signal appears.

Trade 1:
Price close at 1.4696, which is above the upper bound of 1.4564. The ATR is 191 and will be our stop loss size.
Long at 1.4696 with initial stop loss placed at 1.4505.
Closed trade at 1.5575 when Short trade signal appeared for a profit of 879 pips on risk of 191 pips.
Trade 2:
Short signal appeared and we close out our previous long and reverse our position to turn short.
We shorted at 1.5575 with a stop loss at 1.5724, a 149 pips stop loss.
20SMAenvelope-final

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